The Great Wall Street of China

China Top 100 Companies (courtesy of Standard & Poors)

It’s getting easier for Australian investors to get a slice of China's booming economy. Most of Australia's multinational companies have some exposure to China, be it BHP Billiton, Macquarie Bank, or Foster’s. Australian investors wanting direct exposure to the market will find it almost impossible to invest in a company or fund that gets 100% of its revenue from China by picking companies listed on the Australian Stock Exchange. By investing in other foreign markets (especially, the United States), or using well-connected fund managers they can get better, more direct exposure to China's growth.

AUSTRALIAN STOCK EXCHANGE

Australian companies in every sector, from resources to services, are positioning themselves to benefit from China's growth. BHP Billiton Petroleum and Woodside Energy, subsidiaries of BHP Billiton (BHP) and Woodside (WPL) respectively, have existing contracts to supply natural gas to the giant China National Offshore Oil Corporation (CNOOC). Commonwealth Bank (CBA) took a 19% stake in Hangzhou City Commercial Bank in June. Macquarie Bank's Macquarie Global Property Advisers bought a commercial office building in downtown Shanghai on behalf of Lend Lease in January. Scratch the surface of just about any ASX 200 company and you will find China exposure or at least plans for it.

Financial advisers appear to agree on the sectors investors should consider. "The best way to invest in China is selective exposure to companies providing commodities, financial services, consumer goods or infrastructure services to China, either directly or via subsidiaries or joint ventures," says Sue Dahn, a partner at financial advisory firm Pitcher Partners. Pressed for Australian names that could give investors exposure to China, Dahn says: "Consumer goods could be anything from Foster’s to Coca-Cola through to Qantas, as something the rising middle class will partake in."

In infrastructure, Dahn says investment groups Macquarie Bank and Babcock & Brown are already in China, and that Leighton is winning contracts there. Some smaller materials companies like Astron Limited (ATR), which provides zirconium (used in optical equipment) are also benefiting from growth in China, via direct sales and its joint venture in north-eastern China's Liaoning Province.

HONG KONG STOCK EXCHANGE

Australian companies might give investors exposure to China but Hong Kong is the exchange of choice for Chinese companies seeking to tap foreign capital. For direct exposure to the Chinese market via equities, the Hong Kong Stock Exchange is an investor's best bet. Direct exposure to Chinese companies also means that investors are exposed directly to any changes in China's currency regime. In 2005, changes worked in favour of Hong Kong and US-listed Chinese companies that report in Hong Kong and US dollars but generate revenues in Renmimbi. This advantage might be short-lived as China's currency regulators are less beholden to capital markets as their Western counterparts. The downside of Hong Kong-listed equities is that many US and European funds are not permitted to invest outside the US, so Hong Kong-listed companies often trade at a significant discount to US-listed companies.

The Closer Economic Partnership Agreement (CEPA) between Hong Kong (SAR) and the People's Republic of China makes it appear, on paper at least, that investors are better positioned with Chinese companies listed in Hong Kong than in the US. The prospectuses of most US-listed Chinese companies show that investors are actually putting money into companies in the British Virgin Islands or Cayman Islands, which control the Chinese entity via a web of contractual agreements. The Hong Kong Stock Exchange does not require the same level of reporting as the New York Stock Exchange (NYSE) or NASDAQ, so while investors might take comfort in the fact that they are investing directly in a Chinese entity via Hong Kong, they are no more assured of transparency than if they invest in US-listed Chinese companies.

On a more practical note, Australian investors wanting to buy Hong Kong-listed stocks could either talk to their full-service broker or go through Commonwealth Bank's CommSec or HSBC's HSBC Stockbroking, for trades under $100. Before beginning to trade Hong Kong stocks, investors should check their orders will be executed promptly.

HONG KONG ' CHINA INTERNET

China is the world's second-biggest internet market after the US. China had more than 100 million internet users by mid-2005; possibly more importantly, 40 million of those were broadband users. With companies such as search engine Baidu.com (NASDAQ:BIDU) going public in 2005 and online game operator Shanda Interactive Entertainment (NASDAQ:SNDA) topping the NASDAQ 's top performers list in 2004, investor interest in the sector has driven prices to record levels in 2005.

Tencent Holdings Limited (0700.HK) is one of the best-known brands in China's internet sector. Tencent is an example of a Hong Kong-listed company that trades at a clear discount to its US-listed peers. Tencent owns Asia's most popular instant messaging service: QQ. Over the past few weeks, Tencent has shown more than 17 million concurrent users on its QQ instant messenger.

Morgan Stanley's Mary Meeker and Richard Ji, in a 118-page report on China's internet sector in August, described Tencent as: "The powerhouse in China’s rapidly expanding instant messaging market with 60% user share. Tencent has created a strong community with networking effects and high barriers to entry.” Morgan Stanley is a little bit late to the game, some of the world's biggest hedge funds, including Bain Capital's Brookside and Maverick have also been investing in Tencent through 2005.

When Tencent Holdings listed on the Hong Kong Stock Exchange in 2004, many asked the question, "Why not a NASDAQ listing?" On size and performance, Tencent outstrips many of its NASDAQ listed portal competitors (Sina, Sohu, and Netease) and its QQ messenger program is installed on almost all of China's online PCs. The answer probably lies with its biggest institutional investor, MIH, a subsidiary of the NYSE-listed South African media giant Naspers. If Tencent were to list in the US then Naspers could be subject to the US Investment Company Act, creating an administrative nightmare. However, if MIH divests itself of any of its 35% stake in Tencent, then Tencent would be free to list on NASDAQ, enabling a raft of US funds to invest in it. Tencent's executive team has been added to over the past six months, with former Goldman Sachs investment banker Martin Lau joining as chief investment officer.

HONG KONG ' CHINA ENERGY

One of China's best-known venture capitalists, Gabriel Li of Orchid Asia, tells a story of a man in the middle of America who has never been to China but has probably made more money there than any venture capital fund. Li is talking about Warren Buffett, whose listed investment vehicle, Berkshire Hathaway, accumulated 1.3% of PetroChina (0857.HK) for $US488 million in 2003 and 2004. At the time of the company's most recent annual meeting, that stake was worth $1.25 billion.

HONG KONG ' TRANSPORT

Getting goods in and out of China as the economy takes off present huge opportunities for companies permitted to play in the market. China's state-owned shipping and logistics companies continue to enjoy state protection from foreign competitors, so when China Cosco Holdings (1919.HK), a subsidiary of China's giant state-owned COSCO Group, filed for a Hong Kong listing in June, the underwriters should have had an easy time. However, a couple of market quirks and flooding in Hong Kong led to the company being priced at the bottom of its indicative range, where it has languished ever since.

HONG KONG ' TELECOM

China's four major telcos are listed in Hong Kong, with American Depository Receipts trading on the NYSE. Of the four, China Mobile HK (0941.HK) is the biggest and most influential. China Mobile provides mobile telecommunications services to every province in China. The Hong Kong-listed entity bought China's most profitable mobile markets from its parent CMCC. At last count, China Mobile had more than 230 million subscribers.

HONG KONG ' FINANCIAL SERVICES

China's fifth-largest lender, Bank of Communications Company (3328.HK) went public in Hong Kong in June. London-based HSBC already holds a 19% stake in Bank of Communications with the option to take that stake up to 40%. If HSBC can inject some management expertise and risk-management processes into the Shanghai-based Bank of Communications, the company will be well positioned to compete with the bigger banks. Investors should be aware that Chinese state-owned enterprises will still hold control over Bank of Communications even if HSBC exercises its option to increase its stake.

CHINA ' SHANGHAI AND SHENZEN STOCK EXCHANGES

China's Shenzhen and Shanghai stock exchanges are among Asia's biggest by market capitalisation but are virtually closed to foreign investors. Under the Qualified Foreign Institutional Investor (QFII) program, companies with more than $US10 billion under management can apply for a quota to trade Chinese stocks, but foreign retail investors are prohibited from investing in China's A shares. A small number of B shares (55 in Shanghai and 59 in Shenzhen) are available for any foreign investors to invest in, but lack of transparency and lack of liquidity should warn investors away.

Retail Investors desperate to invest in the mainland market can get exposure via funds that focus on China. "Invest via managers who specialise in the region," says Bronwyn Speed, chief financial planner at Mercer Wealth Solutions in Sydney. She advises investors to look for funds that are stock pickers and base investment decisions on bottom-up research.

One such fund manager is Chris Ruffle. He manages the Edinburgh-based funds management institution Martin Currie's Greater China fund, which holds about 24% of its portfolio in China-listed stocks. Managers like Ruffle are able to buy Shanghai and Shenzhen-listed stocks via QFII companies. Martin Currie is one of the few managers that bases its China team on the mainland. Ruffle and his team were among the few managers to realise that China's internet portals would enjoy significant growth in revenue from wireless value-added services (basically SMS) when Sina, Sohu, and Netease's stocks were trading around $1 mark back in 2002. Sina is now about $30, Sohu about $21 and Netease about $90.

THE UNITED STATES

The easiest way for Australians to get direct exposure to China companies is to invest in the American Depositary Receipts of Hong Kong-listed Chinese companies, or Chinese companies listed on the NYSE or NASDAQ. Technology and internet companies tend to grab most of the headlines and dominate exchange-traded funds such as Barclays Global Investors iShares FTSE/Xinhua China 25 Index Fund (NYSE:FXI).

The likes of Netease.com (NASDAQ:NTES), Sina (NASDAQ:SINA), Focus Media (NASDAQ:FMCN) have done well attracting media and investor attention. While the technology stocks have been in the limelight because of stellar quarter-on-quarter revenue numbers, there are still big opportunities in financial services, manufacturing and resources. Royal Bank of Scotland and Merrill Lynch have taken stakes in Bank of China; Deutsche Bank and Singapore's Temasek have taken stakes in Guangdong Development Bank. The banks are taking these stakes ahead of NYSE floats, which will give foreign retail investors the chance to get into China's financial services market.

Most Australian brokers allow clients to trade US stocks but investors can easily do it themselves online. Phil Lin, who lectures in entrepreneurial finance and private equity at Beijing University and Columbia University, uses recent eTrade acquisition Brown & Co, "simply because they have among the cheapest rates on options trading". Lin's attitude to the China market? "I'd rather pay a few percent and have a professional money manager (that is, a mutual fund) make decisions if I don't have time to follow the market."

EASE AND QUALITY

Advisers such as Mercer's Bronwyn Speed caution investors that company management in China, as in most emerging markets, varies in quality. Retail investors can largely sidestep this problem by investing in US-listed Chinese companies or the American Depository Receipts of Hong Kong-listed Chinese companies. This strategy begs the question of tax implications and currency risk for Australian investors looking offshore, but if the issue is to simply get exposure to China, the US is a good starting point for liquidity, transparency and quality of management.

Journalist Paul Waide recently returned from Shanghai where he spent two years as editor of Pacific Epoch, a financial news service.